Monday, August 6, 2012

Something is happening here and you don't know what it is - do you Mr Hempton: Richemont edition

I am wrong often enough to hurt - but rarely this fast. Richemont just pre-announced a big sales increase. I expected at best low single-digit sales increases and the company to guide down. I blogged about it only on Friday. Richemont was a modest sized short position and I was trading it for what I thought would be an earnings miss.

This company sells very fine jewellery and high end watches. By high-end I mean up to half a million dollars.

Richemont is - as I said in the original post - an amazing company that has managed to make super-luxury goods ubiquitous whilst they remain exclusive.

We have a broken thesis rule at Bronte. We search for things that falsify our thesis - and when we find them we close our position. This big sales increase tells me that something is happening in this business that is outside my thesis and not obviously consistent with the thesis.

So we just covered. Loss to clients was about 40bps of our funds under management. It was not the first time and it will not be the last time we make a mistake...

Speculations

As of about five minutes ago we no longer have any interest in Richemont, long or short. But that won't stop me trying to work out what we did wrong. The sales increase is enormous given current economic trends. Lets think this through by jurisdiction...

I would expect a (big) sales increase in Japan because the previous corresponding period includes the earthquake and tsunami.

I would be startled by anything other than a sales decline in Europe. There is an economic crisis there and as one of my correspondents put it - the one percent are becoming the half a percent.

North America is doing OK - so I would expect a sales increase - but low single digit.

South America will - like Australia - be beginning to feel some commodity price anxiety - so sales increases will be small.

The anecdotal stuff out of China and Hong Kong is all bad. Correspondents sent me many anecdotes - all supportive of my thesis - and the plural of anecdote has always been data.

None of this allows for a twenty percent sales increase.

I have heard only one alternative thesis - and that is that sales within Mainland China are increasing - not because they want the watches and jewellery but because they are portable wealth that you can move over a border with or store like gold. It might be true - but watches and jewellery strike me as poor stores of value. The anecdotes in my email suggest that the gray market is weak - but those anecdotes are so thin that I doubt them.

59 comments:

I think in a normal working economy your thesis about Richemont was and is absolutely right.But as you could see it last week in the stock market with that abnormal ups and downs you realize that we are in unnormal times. It feels like your shipping with your boat in the atlantic and you cross stormy weather with big waves.

As everybody knows Richemont is selling luxury goods with world famous brands. Everybody knows it.

A lot of rich "new" rich people in the Region of Iran, Irak, Turkey, China earned a lot of "black Money" who didn´t pay taxes on their earnings. So this money is flewing to Richemont, because as you described watches and bags can be easily carried from country a to country b. And if you need money you can sell this stuff for less than you paid , but it´s much better than paying tax.

So I think Richemont is a kind of a "Swiss Bank" for some "New Rich" people from undevelopped countrys. If you bring your money to the bank you will get only a saving book. But if you bring your money to richemont then you get a luxury good. If the bank goes bancrupt you or tells other countrys government about your financial sitution (Swiss-Germany)you can be caught or loose your money. But if Richemont goes bancrupt you have the luxury good you cann sell it to other people and you are ananymous.

(Sorry for my bad english, I hope I could tell ou my thesis. Richemont is "the new Swiss Bank")

Potential answers to your conundrum (In descending order of likelihood):

1) Your HK Sales Data is wrong. It was pointed out by a commenter that it is sample data from 3000 stores, and not actual sales tax receipts. There may be something wrong with their sampling methodology or the figures may have been cooked by the retailers or the HK gov.2) Your HK Sales Data is right, and some other market (Russia, the Middle East) has taken up the slack and more. This could be down to better marketing in those regions due to the dropoff in HK sales.3) The sales growth is a result of channel stuffing. Persistent Richemont reps have persuaded stores to take even more inventory (at a discount) and this has resulted in a blip in sales growth, which merely kicks the (explosive) can a little further down the road.If this one turns out to be true you will curse yourself for closing your position.

I look forward to the followup - It is always nice to see smarter people than me crunch this stuff, and as a non-investor strangely thrilling when they're wrong :)

Hi John, I came across your blog on Rich this morning on Business Insider, for the first time I actually choose to submit a comment, heading is, Interesting but flawed logic, may help. The use of watches to flow capital back to China is also true.

Simple - you went to great lengths to comment on the proliferation of Chinese 'princelings' (or whatever you called them), and now you're surprised that China demand has held up. You could have gone long on your own evidence, alone.

What's a bug from various points of view is a feature if you're Richemont.

jewellery is a very good store of value. Its better than gold or silver coins, even though the gold and silver content of jewellery is lower. I have found that jewellery market is more liquid than coin or bar market for precious metals.

Why don't you spend a day at the Galeries Lafayette in Paris? Chinese continue to buy expensive watches & jewelry. They buy a bit less in the mainland & HK. Way more in large European cities. I insist: spend a day at the Galeries Lafayette in Paris.

I have the utmost respect for you, John, in placing the trade and 'owning' it when wrong in such a public forum. No excuses. Rare indeed.

The money-laundering properties of watch sales in HK have to be seen to be believed. People buy expensive watches and LITERALLY walk them next door and sell them at a big discount for cash whereupon the second jeweler sells it back to the guy who first sold it... and round it goes. Everybody's happy... almost!

FWIW, I happen to think your thesis is spot-on, but like many others in a world of interventions, getting the timing right gets increasingly difficult.

If anyone has been to hk/china since April of 2012, they will know john's thesis is completely correct. China is slowing down massively and china luxury consumption is falling off a lot. Look at the hk listed watch retailers (hengdeli, oriental watch, emperor jewellery). Why would richemont be immuned to the pain felt by their retailers?

First of all, I have become an avid reader of your blog - consistently excellent work.

Secondly some suggestion on the thesis violation.

1) Perhaps your point doesnt directly impact ostentatious consumption. Rather it impacts the display of ostenatious wealth. Chinese cleptocrats are still buying the watches, its just that they are not wearing them in public anymore. If you want to wear your watch take a trip to Vancover.

2) When Khodorkovsky was arrested in Russia, it was not a clampdown on oligarchs. It was a demonstration that disloyalty to the new regime would not be tolerated. The Putin loyalist oligarchs flourished post Khorokovsky take down.

3) Perhaps what we are witnessing is just the start of the power struggle in China. It isnt clear yet who will win or what policies they will institute. In that enviroment capital flight was accelerate. Richemont benefits from this capital flight.

4) China is definitely slowing. But China still has ammunition to stimulate its economy. It wont help in the long run, but they wouldnt be the first to desperately press the f9 button over and over again. It is the only button they have. In the short run this will boost asset demand. Perhaps these items of jewelry are assets?

I just thought I'd throw an anecdote in here. A few years ago my young cousin was doing work experience in the London offices of a firm that may have been Richemont, if you get my drift. They were paying her around £300/week. She received a phone call from the Paris office inviting her to transfer over there. The pay would be much less, but imagine the prestige! One small requirement would be that she would have to register at a university and then fail the exams. The company could thus continue to claim the subsidy for giving experience to students. She stayed in London and is now loaded. I'm not sure if this tells you more about France than about the ethics prevalent in luxury goods sector multinationals.

1) LFL rev growth rate has halved per the numbers2) Revs recognized now reflect orders placed several months prior, when trading was better for retailers3) Absent data on working capital, how to judge the quality of the EBIT? What if they built inventory and took benefit to GM? What if there are one time items? Lots of unknowns4) Bar now set higher for full H1 numbers5) Curious timing of statement. Mgmt piqued?6) Boss has publicly described China biz as like a "black tie dinner on top of a volcano." An additional course has been served, but what else has changed?

i think all this talk of new and emerging millionaires is a little off. 500k items are out the price range of the average "millionaire" as alsorts of things are being factored into that million. Rather we should be looking at the behavior of their existing costomer base. I mean, didnt the Sultan of Brunei buy Asperys only to find out he was their biggest costomer? lol

The thesis is correct, the timing is wrong. Just because the princelings are slated for a take-down doesn't mean that they'll come down soon. And the market can stay irrational longer than you can remain solvent.

It's the reason I don't short. Not because I don't want to, but because I'm not confident enough in the information available + my reasoning to hold out for the long haul. In the end, you have to play to your own strengths: not doing so will always be a loser's game.

In my opinion you aren't tying two threads of your theses on China togethor.

1. Luxury goods retailers will suffer

2. Chinese Kleptocracy means that the poor will suffer.

The super rich in China are well above the law; most of these goods aren't purchased as a 'store of wealth' but they are also a form of grey income... bribes... As far as I can tell these luxury goods will continue to be in demand as long as favors needs to be paid in China

I am a little disappointed in you. Your earlier posts on shortings US listed Chinese companies were brilliant. Well researched and not a hint of trusting an anecdote. You sent people there to report back directly.

I think if you want to invest in China you need to be there on the ground. Long or Short.

The difference with your earlier positions was that you were actually shorting the US system

I think there was an assumption in your narrative that was flawed. You assumed corrupt bureaucrats and princelings were buying watches and other glitz for themselves and because they would not want to flaunt their wealth, they would cut down, desist ... I believe that most of the luxury items are bought as gifts for mistresses (who can flaunt the stuff in private before sugar daddy) or as gifts to lubricate relationships (aka bribery). I doubt bribery is going out of fashion very soon in China (mobile execution squad or not)

I wonder if your personal distaste for expensive watches clouds your investment judgment. A mentor of mine liked to talk about a friend of his who passed on what would've been a nice trade on a pizza place IPO because he tried the food and didn't like it (this may have been Pizza Hut? I'm not sure).

I've wanted to short ADBE for years because I hate Flash and Acrobat so much, but I took that as a sign to stay away.

Based on the fact that Richemont does not really trade on the US markets (CFRHF, with no volume), I would have a general question? From which markets do you find yourself executing most of your trades? And do you find that any particular market offers the best short opportunities.

dear john, compliments for this excellent blog, which i never miss. i think though that your analysis of the chinese kleptocracy, is a bit obfusctaing the fact that most people like watches and the fine skill to build complications. you might not like watches, but most other people do...especially in Asia. I have been living in singapore for 8 years (i am swiss) and i can tell you that also affluent people (not even millionaires) love and buy expensive watches and even have real fine collections. You are also forgetting that between china, indonesia, RoP, malaysia, india, thailand (etc) you will have a lot of non-kleptocrats which will buy a Audemars Piguet Royal Oak, which can cost as "little" as 25K USD. speaking about jewels, you should know that while in europe, USA and Japan 80-90 percent of the brides get a diamond ring, in china the percentage is rather 15%....so the potential demand is enormous. and for a girl to get a diamond engagement ring, is not to boast, its rather cultural and even normal. I think the mistake you made, if that you put emotions into play (you obviously are enraged with the kleptocrats). I congratulate you for closing the position and the adherence to you trading discipline, as well as the reflection over the mistake. That is why i think you are a very good HF manager. RgdsAlex

Nassim Nicholas Taleb (The Black Swan, Fooled by Randomness) argues that in a political collapse, jewelry is a more fungible store of value than bulk gold.

Unlike most investors, he argues this from direct experience, living in Beirut during the Lebanese civil war of the 1980s.

When centralized government breaks down, warlords arise naturally and take control of basic distribution (i.e. food). Warlords' currencies are image and power, so jewelry and weapons are of immediate use to them.

Taleb discusses this near the front of one of his two popular books, but I forget which one.

Is it possible that you were right, but just a bit early? Maybe the sales have slowed dramatically at the retail level, but the slowdown has yet to make its way back up the distribution chain to the manufacturer. I don't know enough about the high-end watch business to know if this is possible.

The sell-in does not match the sell through in China - the sell through in China according to our sources is down substantially (due to less gifting, weaker economy, etc.). However, the retailers had to order 6 months in advance so there is potentially a 6 month lag before this hits. That could be what you're missing.

Only thing you are missing is short luxury exposure with a little scam, check out TUMI. CFO is head of audit committe of GMCR. IPO funds were used to buy our insiders and to pay bonuses (for real!), prospectus: http://www.sec.gov/Archives/edgar/data/1535031/000119312512173265/d336000d424b4.htm#tx336000_4

I think the thesis is not accurate discription of the big picture, note that despite corruption, China is producing more and more millionars every year, 1m is not a lot of money in eastern coast cities. They are recession proof because even if the economy slows, they have ways to grab more money from taxpayers. Though every stock will have its turn, not this time.

There are problems with your analysis regardless of whether the trade worked. First, focus only on the reasons for entering the trade and not other factors with hindsight to avoid a perception bias. Second, the original factors of arresting Bo Xilai’s wife and Hong Kong jewelry tax revenue were hyped. The fall of Bo didn’t necessitate a fear of revolution nor new populist legislation because Chinese politicians don’t care about voting results in a communist state, unlike the democratic West. Also, Hong Kong jewelry tax revenue could dip because of tax evasion, changes in purchasing habits to legally decrease tax liability (i.e. purchase items in Japan), or a decrease in jewelry consumption. Assuming a decrease in jewelry consumption in general does not imply any particular company will have lower sales. For example, assume X, Y and Z Company has $5, $10, and $16 in annual sales respectively. Now assume sales are subsequently $10, $4 and $8. The total sales have decreased 29%, but X Company has experienced a 100% increase in sales. At best, one should only short the sector (i.e. ETFs) unless more data become available. Regardless, one still cannot be sure the decrease in Hong Kong jewelry tax revenue is substantially due to lower consumption of jewelry. In gist, I would have done nothing and looked for better odds.

Tough loss - but your willingness to be so forthright is an uncommon trait and will hopefully make you a better investor over the long haul.

It seems like a decent chunk of the impressive performance was due to CHF weakness - which though it will likely continue is hardly the stuff of a high quality beat.

Assuming the HK sales tax data was roughly accurate (as pointed out above it may not be) it will be very interesting to see how the rest of this year and next pans out. Channel stuffing is far from uncommon in Greater China but it is usually Chinese companies doing the stuffing.

One commenter claimed the jewelry market is more liquid than the gold coin market. If he's referring to Eagles, Pandas, Maples etc I think he's dead wrong. However, if you have to leave in a hurry, $500,000 of gold coins or bullion is very heavy. A Richemont watch weighs nothing.

John, the logic behind the thesis may be broadly right. But to get the anticipated events to set in, you have to get the timing right. Maybe you are just ahead of time (like Solar stocks which I tracked closely when you blogged about it). Economic shorts when there is little leverage involved requires reliance on channel checks - when Einhorn shorted Samsonite (from his book) ... Or as Chanos said when asked why they did not short the internet bubble he said something like there was no debt involved and so did not short the internet stocks.

I think it was a decent call that didn't work out. I do think that it relied too much on theory versus data. As you say anecdotes become data but when you are dealing with a firm as large as this one the problem is harder. Lots of geographies, channels, moving parts. You can get lots of input and still be dead wrong. It makes it worse in some regards because as you get more input you grow more confident even though you are well below the threshold for a strong call.

If this were a technology company I could help you out more in terms of what else to do here and if there is a latent trade to be had. Firms like Richemont are too far afield for me.

As a Swiss resident I have been amazed by your walks through some of the companies based here including your perfume story!

In regards to Richemont, they are as all luxury good providers extremely reliant on Chinese sales so the trends that you have spotted will certainly make their way into their books. But really the products Richemont sells do defy gravity even though your personal interest in them is next to null. (I will admit a small personal upset that you cant appreciate the beauty of a Lange, but I must say the Glasshutte is an old favourite..). After the Swatch group provided us with another record H1 in June in their watches and jewelry section, the timing of your doom was a little puzzling. Switzerland's watch export as you referred to is half way in 2012 slighlty exceeding 2011 record year so far (could obviously change, but we still have not done Christmas).

Also anecdotal - but in my crowd a lot of Germans are willing to spend some money on flashy pieces so when they go off on holiday to Greece and Italy in August they can show off not just the credit spread, but also some pretty pieces of luxury items!

I am looking forward to your next analysis, but maybe a less personal take on the products would stand a better chance. Or as with any new relationships in general - timing is a lot more important then we would like to admit!

Why would you be shocked by anything other than negative development in Europe?

Tod's reported 5% growth in Europe (excluding Italy in Q1).

As recently as 26/07, LVMH reported 8% growth in Europe for H112.

Okay the thesis for the Richemont bulls probably isn't "Europe surprises on the upside", but all the same, if that was a part of your short thesis, you probably could have saved yourself some headaches by having a read through the commentary from some of the peers.

John, it is always dangerous to bet against the super-rich. Was it not a logical conclusion that prices for prime property in London would crash once the financial crisis was upon us? But there was only a minor and short-lived blip before they resumed their steady climb. Crisis, what crisis?

Sorry to hear you got smoked on that trade mate, lots of hedgies on our side of the water were already short up to their eyeballs of this one (Europe in the Toilet and just waiting for China to also flush itself down the bog).

Your "mistake" was banging it to early because what you say will come through sooner rather than later (you might have over analysed the company already ;-) ).. Already saw one or two downgrades coming through post the update.

If you really want to go short of stocks which have gone full retard as far as valuations are concerned you should come short some South African retailers and maybe go long Richemont against it...

One thing: according to their statement it was actually up 13% in constant currency, which is a fair slice lower than 16%. They've obviously benefited a lot from EUR weakness vs. JPY and USD/HKD/CNY.

Secondly, look at the HK sales data you link to: it's slowed from New Year but the Mar-Jun average was 164 this year against 150 last year, which is a 9% increase. So we've now only got a 4% discrepancy.

In addition, Jan and Feb were two of the four highest months on record for the index, up around 200; as some commenters have said, it's possible that Richemont's 4-month period reflects some orders placed back then.

China and HK make up 27% of Richemont's sales. Going back over the last four years, the growth rate of that segment's sales has been 47%, 45%, 23%, 17%. It's worth noting that this doesn't map very closely to the HK jewellery index so we can't take one as a proxy for the other.

This is a very rough estimate and ignores currency effects, but take 13% of their 8.9bn revenue last year. That's 1.2 billion.

China/HK growth only needs to match the last two years' full-year growth rate (and again, there may be a New Year effect) to pretty much account for that on its own. You could explain half of it by "other Asia" growing at last year's rate, or about 2/3 of the rate it saw the previous year.

Europe's been in the dirt for several years now but "other Europe" is Richemont's second-biggest segment and grew at more than 25%pa over the past two years. Matching that rate makes up about a third of the difference. It's not hard to get to 13% sales growth for the global business.

I'm sure they've benefited from a delayed Chinese New Year effect and I wouldn't be surprised if we do see some slowing in the months ahead, but I think the slowdown in the economic data wasn't as early or as dramatic as you hoped, especially given issues such as money laundering and the dearth of mainland Chinese investment options.

This is a very big business which has seen some startling growth that won't necessarily come juddering to a halt because there's more coal piling up at Qinhuangdao. Aussie property is overvalued too, but Beijing is still full of people pushing it as a great investment: http://marginalrevolution.com/marginalrevolution/2012/08/beijing-notes.html

Simple. The problem was in the data. Your Hong Kong data was referring to the price level of jewels and luxury goods in Hong Kong instead of your understanding as "tax receipt". Hong Kong has no sales tax on luxury goods.

That means your thesis could be right but you short in a wrong timing. Everyone is talking about slowdowns in China in recent months, inventories are actually building up as far as I know, but that doesn't lead to a disastrous H1. Wait for Q3 I guess.

I read your first post last week, and now just back from Paris, read your follow up.Because of your first post I visited quite some places that sell luxury goods: Galeries de la Fayette, Au Printemps, Le Bon Marché and Rue Saint Honoré. Just to have a look at what's going on. About 80 % of the visitors were Asian and I guess about 99 % of the buyers were Asian (I would rate Chanel as the top followed by Louis Vuitton). Sales of luxury goods in Europe are up, but you need to know that the main buyers are Asians and sales to Europeans have declined. No wonder when you know that in China prices can be 50 % higher (example Gucci in Sanya in the province Hainan).Prada estimates that 60 % of all sales go to the Chinese. I would worry about this imbalance.

anyone who will quote a bob dylan song (ballad of a thin man) has my attention. I have no idea why your thesis turned out wrong, probably the same reason Manhattan apartments are going through the roof. All that FED/ECB money has to find a home somewhere so why not watches and upper east side condo's. Keep up the work and the Dylan quotes.

I used to cover this sector at a HF for ~2 years where we were both long and short. I think you are just a bit early ... we saw a whopping downturn in China for a couple of quarters post Lehman before we had a very vigorous recovery, you can see this in the swiss watch data if you go back ... so China and high-end china are not immune. In addition, there used to be a backlog in the very high-end stuff with a waiting list for up to 18 months so you could have to wait 6 - 12 months to see the impact of China's slowdown. As discussed, we also saw channel stuffing. Interestingly Tiffany just announced -5% organic (same store) sales growth for asia pacific. Note BRBY is very vulnerable given its valuation, high fixed costs footprint, exposure to soft luxury (very cyclical), and surely the likelihood of a strategic acquisition (e.g. by LVMH) will have diminished until we have clarity over the soft/hard landing situation. Swatch also has a high fixed-cost base due to its industrial division although it does not have the retail cost-base of Richemont. Jewellery is more cyclical than watches, and very high end is not defensive, just look at what happened to Bulgari before it was acquired. Swatch and Richemont are great businesses with fantastic management, and they will take share and emerge stronger but they are like industrials : very very cyclical!

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The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.